A house in foreclosure was quit claim deeded from son to father. The house is slated to be sold for more than what is owed. The loan is in the son's name. However, the sale proceeds will be in the father's name. What will the father's tax exposure be? Will he be taxed on the full amount of the sale (for example, $200k) or only on the net proceeds (for example 50K) as a short term capital gain? The net proceeds will not be rolled into another property but will be disbursed to fulfill other debts including a divorce decree and child support. The father will not receive any compensation from this transaction.
It hasn't closed yet. If the father will be taxed on the entire amount ($200k) then there is time to cancel the quit claim deed and have the proceeds issued to the son. The son is incapacitated at the moment. They did the quit claim deed thinking it would be easier to manage the sale and sign all the paperwork, not thinking ahead about the tax consequences. Thank you.
First the mortgage is immaterial to this situation and it not part of the profit/loss calculation. And the ability to roll the profits into the next personal residence went away back in 1997.
Next, if this was the son's personal residence for 2 years out of the last 5 then HE needs to sell the home to get the personal residence exemption on the first $250K of profit.
Purchase price + cost to purchase + cost to sell = basis
Selling price - basis = cap gain or loss
Last ... dad was given the home so the basis to the father is the same as the son's basis HOWEVER he is not eligible for the exclusion since he did not own the home for 2 years and will pay cap gains tax on every $ of profit.
House purchased 4/2017 so it hasn't been 5 years. So then is personal residence exemption a moot point?
Also, for the dad would it be short term or long term capital gain tax rate? The dad has only been on the deed a couple of months but the son was on the deed since 4/2017 (purchase date).
Thanks so much!
@Mike9241, can you be more specific about possible legal issues? We do plan to contact a real estate attorney but would like to be more knowledgeable before the meeting.
Son did not need to own the home for 5 years just had to live in it and own it for 2 out of the last 5 years for the exclusion.
And I agree ... talk to a RE attorney to make sure you have your ducks in a row. Your realtor & or closing agent should have also given you some advice for this situation ... the Quit Claim may not have been a good idea or legal if the son cannot sign a contract in any manner.
Father and son screwed up. If son had sold the home, he could have excluded up to $250,000 of capital gains, on the basis of having lived there as his personal home for at least two of the past five years, and owning the home at least two years.
Because father has neither lived in the home nor owned it for at least two years, father must pay capital gains. The capital gains is the difference between the selling price and the son‘s purchase price in 2017, it has nothing to do with how much is realized before or after the mortgage is paid off. It will be a long-term capital gain, because when the son gave the father the house, that included the son’s ownership period (which was more than one year), and it included the son’s cost basis (which is whatever the son paid in 2017).
Because the son gave the house to his father, the son must also file a gift tax return form 709 reporting the value of the gift. Gift tax is not usually owed unless the giver’s lifetime gift total is more than $11 million, but the IRS requires the form to track large gifts against that lifetime total. TurboTax does not include form 709, it is filed separately but is also due at the same deadline, which would be April 15, 2022, if the transaction occurred in 2021.
Father and son may have violated the terms of the mortgage. This is not likely to result in criminal issues, and if there is a sale in process, it is likely that the mortgage company will be happy to get their money, but if there are any delays or unexpected complications, father and son could get in quite a deal of trouble with the mortgage company. Legally, father is not required to pay off the mortgage. However, since there is a lien on the home, another buyer can’t buy it unless the lien is released, and son can’t release the lien without paying off the mortgage, which son can’t do because son doesn’t have any money. It’s not clear how the sales money will go from buyer to father to son to mortgage lender.
You definitely need to see a real estate attorney. The simplest thing to do may be to quit claim deed back to son. If the buyers attorney gets wind of this complication, they may have legal cause to back out, and it may be in their best interest to back out since they would have great difficulty in obtaining clear title from the son’s mortgage lender.
If the son was known to be incapacitated in the near future, it would have been better to execute a durable power of attorney rather than transferring the house. Hopefully the son’s condition is temporary.
If not, and there is no power of attorney for other important issues that may come up, it may be advisable to go to court to get someone appointed as the son’s guardian and legal representative. That person might also be able to swap the house back for the better tax treatment.
In any case, when someone is facing a long term incapacitation, such as due to a chronic illness or end of life issue, it’s a good idea to see an attorney who specializes in such matters. That would probably be an elder care law firm, since many of the issues will be the same with a younger person facing illness or end of life.
One final thought.
Since there is a mortgage on the property, the quit claim deed might be invalid. It might not be allowed to actually transfer ownership without permission from the lien holder. This would be a matter for state law, and you can also check at the county clerk's office, where the original mortgage lien is recorded and where the quit claim deed should have been recorded.
If the quit claim is invalid and the son still owns the house, this helps with taxes but the father needs to go to court to get himself appointed as the son's personal representative. Again, see an attorney.
@Opus 17 wrote:
Since there is a mortgage on the property, the quit claim deed might be invalid. It might not be allowed to actually transfer ownership without permission from the lien holder.
Quitclaim deeds are virtually never invalid merely because there is a lien (or liens) on the property. The mortgagee may be able to invoke a due-on-sale clause, but the actual transfer would not be invalid.
Permission from the lienholder is not required for a valid transfer as a quitclaim deed merely transfers the interest held by the grantor if, in fact, the grantor has any interest whatsoever (the lien follows the transfer, regardless).
I concur with the suggestion to seek local counsel for this matter.
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